Is the Bailout Needed? Many Economists Say “No”

Traders on the floor of the New York Stock Exchange react to turmoil among investment banks on Wall Street. Many of the nation's brightest economic minds are warning that the Wall Street bailouts a dangerous rush job. (Photo: Spencer Platt / Getty Images)

by: Kevin G. Hall, McClatchy Newspapers

Washington – A funny thing happened in the drafting of the largest-ever U.S. government intervention in the financial system. Lawmakers of all stripes mostly fell in line, but many of the nation’s brightest economic minds are warning that the Wall Street bailout’s a dangerous rush job.

President Bush and his Treasury secretary, former Goldman Sachs chief executive Henry Paulson, have warned of imminent economic collapse and another Great Depression if their rescue plan isn’t passed immediately.

Is that true?

“It’s more hype than real risk,” said James K. Galbraith, a University of Texas economist and son of the late economic historian John Kenneth Galbraith. “A nasty recession is possible, but the bailout will not cure that. So it’s mainly relevant to the financial industry.”

The Paulson plan will get some bad assets off the balance sheets of troubled Wall Street institutions and commercial banks. That may help thaw the lending freeze.

But it wouldn’t reduce the crush of homes in or near foreclosure, said Simon Johnson, a professor at the Massachusetts Institute of Technology. That’s a problem that will surely grow worse if the U.S. economy enters recession, leading to greater job losses, which feed a vicious downward spiral of even more foreclosures and defaults on car loans and credit-card debt.

Americans are spooked by talk that financial Armageddon awaits.

The global financial system nearly melted down last week when investors pulled out en masse from money market funds and the short-term debt markets that help corporate America fund its day-to-day needs.

These traditionally have been viewed as safe investments for ordinary Americans, so the flight from them struck fear in the hearts of policymakers.

Few economists, including Galbraith, are willing to discount completely the chance of a financial collapse, given the turmoil in credit markets and banking.

“My sense is it will delay a disaster, given that you only have three months left in this administration. But it will not cure the problem in the (financial) industry or prevent the shakeout and downsizing of the industry,” Galbraith said.

Many lawmakers also expressed skepticism.

Coming out of the White House on Thursday, the ranking Republican on the Senate Banking Committee, Alabama’s Richard Shelby, held up what he said was a five-page list of economists opposing the rescue plan.

“This is not me. This is economists at Harvard, Yale, MIT, University of Chicago, our leading universities,” an exasperated Shelby told reporters. He called the administration plan “flawed from the beginning.”

Johnson, a former assistant director of research for the International Monetary Fund, said: “I think the main problem is what they have on the table is not truly comprehensive, and I think it’s probably not decisive for that reason.”

With the problems in money market funds and the fact that banks have stopped lending to each other except at high rates, the global financial system is as weak as it has been in modern times, he said.

“It’s a very dangerous situation. I would not recommend doing nothing. The world financial markets were in cardiac arrest last week,” Johnson said.

What Congress and the administration failed to do, Johnson said, is develop a mechanism to quickly modify distressed mortgages and prevent even more empty homes from being dumped into real-estate markets in freefall. The plan also doesn’t help banks bring in new capital to boost lending; instead many are sitting defensively on their reserves to offset expected loan defaults.

“I think the rush that happened this week is unfortunate,” Johnson said. “I don’t think it is enough.”

Another doubter of the Great Depression theme is Kenneth Rogoff, a Harvard University economics professor, who thinks the intervention may prevent or delay the necessary failure of weak financial institutions.

“It is time to take stock of the crisis and recognize that the financial industry is undergoing fundamental shifts, and is not simply the victim of speculative panic against housing loans,” he wrote in a syndicated column. “Certainly better regulation is part of the answer over the longer run, but it is no panacea. Today’s financial firm equity and bond holders must bear the main cost, or there is little hope they will behave more responsibly in the future.”

Some analysts think the most important steps to avoid another depression may have already occurred without the $700 billion bailout.

“Last week we came real close to a financial economic meltdown because of the run on money market funds, resulting from the bankruptcy of (investment bank) Lehman Brothers, and I think insuring the money-market funds was enough,” said Ed Yardeni, a veteran Wall Street analyst. Last week the Treasury announced a $50 billion insurance plan for money market funds, which restored confidence in them. “It wasn’t necessary to move to Plan B.”

Doubting the financial Armageddon scenario, Yardeni said another measure that could have the same effect as the $700 billion rescue plan is simply to change accounting rules for bad assets – mostly bonds with mortgages as their collateral.

Right now, banks and others with this toxic debt by law must write down losses every quarter. They are forced to put a present-day value on these assets. Yardeni thinks suspending this rule could do the job without taxpayer money.

“There are quite a few of us who think that could have stabilized the situation quite effectively,” he said, adding, “I think it (the bailout) was rushed, and certainly we didn’t give other reasonable, cheaper alternatives a chance. But at this point it is what it is, and we all have to pray that it works.”

5 Responses to “Is the Bailout Needed? Many Economists Say “No””

Quite simply, the “crisis” is a lack of liquidity in the holding of certain assets, that DO have value, but the market doesn’t want right now…at almost any price.

If the US were to do this (the @ Paulson Plan) correctly, we could buy at current market, hold for awhile, and make back more than costs…easily.

Buying the devalued assets at their current low prices would free up the capital the companies have tied up in them, allowing them to invest back in the economy again, and protecting their stock value and the millions of people that hold stock in them.

It is VERY near-sighted to think that this issue is only a Wall Street problem. It is an every street problem, and can be fixed—without costs.

So, why are a large number of people hell-bent on not doing it? First, they must not understand. Second, they fear what they don’t understand, need someone to blame, and find that their only power while still being powerless is saying “no”, even though doing so is self damaging, US economy damaging and stupid.

You may say “it’s not necessary”. This in in fact like saying “both of my legs are not necessary, as I can use crutches to get around.” No….not adequately for most people.

Speculative lending, real estate bubble burst, a public bail out that leads to a BIG (read “great”) depression; does any of this sound familiar. Any plan that taxes the working class to bail out irresponsible management what repeats it’s policies time and time again is criminal.

I have a better plan. Let em fail. Let the bad loan takers and bad load writers go down together. You can’t get something for nothing!

9/11, Enron, false justification for a brutal war, fixed elections and now they fail the economy. Make it happen on their watch and two generations of responsible citizens will have to live and die before the radical, fundamental, religious zealot, domestically terrorizing Neo-Conservative cabal can return! Blame them for what they have created, show our children how never to lead by their example!

Frame the entire administration as a failure of morality. Failed leadership of the greatest nation on earth due to lies, shock and psycho-oppression of sensible ‘free’ thought and expression. Demand the return of capitalism to it’s rightful owners, American who sweat and belch taxes so our freedom can reign and shine as a beacon of democracy for all to share and learn from.

You miss the point of capitalism. Capitalism rewards capital, not the laborers beyond their “guaranteed” (a foolish certitude if there ever was one) wages. Always did and always will.

The only reason to “bailout” these institutions is the pain that their failure would have on the mainstream. From job loss, to 401k devastation, to further plummeting of housing prices, to small businesses losing operating capital to hold over during the slowdown, etc. lack of liquidity will cream the bread and butter US citizen.

That pain is real, acute and certain. Action should have been taken last Thursday.

It’s a failure that we didn’t get this passed already.

The bailout proposal saves a FEW on Wall Street, but could save Main Street

The capitalism line is complete bullshit. Sounds good but isn’t true. The entire capitalistic system was set up to seek out capital for MANUFACTURING and BONDS. Not for a grand Casino of speculators.

The pain ma and pa and grandma are feeling in their 401K’s are caused by wallstreet putting a gun to Amwerica’s head to force them to give them hundreds of Billions. They actually had the nerve to turn down an early proposal. This is extortion pure and simple and giving in to an extortionist dcoes not make him go away.

The credit “liquidity” problem is only a problem becasue the big banks are HOLDING the money. They have money, they are just “worried”. Worried my ass, they are extorting us and should go to jail for it. Profiteering in a “time of war” (God I never thought I woudl say that but it seems oddly appropo) is a federal crime..

No, we have to draw the line in the sand this time. Stocks go down, and they will go right back up once a real system is put in place that limits the volatility that only makes the rich and insider speculators rich while fleecing the working class of their 401K’s and pentions. And we are fortunate that enough Republicans representitves know they are going down this year and so they are actually showing some spine in a lkast ditch effort to separate themselves from this mess they have created..

Good luck!

There isn’t a lot of unsurety amonst economists. The majority all seem to say this plan as it stands is a mistake, wall streets extortion play be damned.. We all have to just hunker down and be resolute, this is a turning point in American History and a critical juncture. WE HAVE TO DO THE RIGHT THING< not just the expedient one.

It appears that you don’t understand the realities of liquidity etc. Banks CANNOT lend until they haave liquidity, which means either getting more cash, reducing bad debt. dtc.

I have not seen a clear but accessbiible explanation of the Paulson, please so….

Here is a rough approximation of the ORIGINAL Paulson plan, why it would work, how it would work….

The gov’t buys $700b 9% mortgage backed securities at .50 on the dollar.
Now, the investments yield 18% (because of buying at a discount)
The cost of debt service is 5%, for a positive interest spread of 13%.
BUT, we know that some of these loans are “troubled”.
We lower the consumer’s rate from 9% to 6%…saving millions of homeowners from foreclosure, stabilizing neighborhoods and property values
But remember, we paid .50 on the dollar for the MBS’s, so our YIELD is 12%.
We SELL these back on the market a 7%.
The end investor spends the cost of 7%, and gets the yield of 12%…wahoo…sold in a hurry!
The government uses SOME of the money made from selling the 7% yield/5% cost notes to fund default insurance via a private hedge fund, akin to FHA.
Since investment banks can loan 30 to 1, $700b frees up $21 TRILLION dollars of liquidity for investment.
So, in summary
No cost
Instant liquidity
Homeowner’s save their houses.
Housing prices and neighborhoods stabilize.
I realize the above is a rough explanation, but it’s close enough to see that it works, why it works,and how it works.

Of course, we can clean up regulation for later, go after crooks, etc. so that we reduce the risk of this happening again.

To oppose this easy, fast and thorough fix was and is stupid.

The rich will get richer if we don’t get liquidity, as they will be your and my assets at fire sale prices, while we struggle to keep eating.